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Know Your Valuation

Venture investors will often say that Excel spreadsheet models and Discounted Cash Flows are worth less than the paper they’re printed on. Many entrepreneurs will present a pro-forma, showing a Billion $+ market and aggressive revenues to capture a percentage of that market. While it’s good for the founder to go through the financial exercise, the top-line numbers are not very meaningful for seed-stage companies.

But, startups still need to be valued, and a good place to start is by looking at the landscape of seed-stage, angel deals in the recent past. Here are the valuation numbers according to two reputable sources… starting with the source that Jeff Carter cited, The Halo Report.

According to the 2013 Halo Report, a joint effort by the Angel Resource Institute, Silicon Valley Bank and CB Insights

After reviewing the standard round sizes and valuations, for context, the next logical step is to analyze the common methods for estimating valuation. There are numerous ways to do this, but four of the more common methods include:

This method looks at five, major, equally-weighted criteria, including Team, Idea and Prototype and then allows one to assign progress for each, after which a simple formula allows you to add up the numbers to arrive at a valuation.

Naturally, this approach allows one to score 12 factors for their perceived risk. It considers a broader range of criteria, equally-weighted, than some other methods and also adjusts for vertical and location.

Valuation is not an exact science, but knowing the averages and using these methods or an average of their results, can help in approximating price. When one encounters other angel investors or startup founders that are an order-of-magnitude off of these averages… judgement is often called into question.

Pricing a fundraise appropriately has tremendous impact. For the investor, the difference between a $2M valuation and a $4M valuation, can result in a 2x better cash-on-cash return and a significantly higher IRR for the portfolio of investments. For the founder, pricing too low can result in giving too much equity away. While pricing too high can lead to the Series A crunch. If you’re not familiar w/ the Series A crunch, in short, it is the inability of founders to raise a subsequent Series A round, largely because the valuation at the seed stage was over-inflated. This a growing issue and, unfortunately, leads to the death of many startups.

Remember, the goal is for investors to receive a healthy return and for startup to have the opportunity to realize that return. The next time you find yourself debating the price of a fundraise… don’t ask yourself how much you can get. Ask yourself what is appropriate.

Been re-listening to @TheFullRatchet while walking the dog lately. Lots of good gems in there for founders and investors alike. If you're raising money for your first time, go listen to episodes 1-15 pronto and send thx to Nick Moran for the cheat sheet. itunes.apple.com/us/…